Issues in Accounting

1

Intangible Assets

InstructorInstructorAdnan ShoaibAdnan Shoaib

PART II: Corporate Accounting Concepts and PART II: Corporate Accounting Concepts and IssuesIssues

Lecture 14Lecture 14

2

1. Describe the characteristics of intangible assets.

2. Identify the costs to include in the initial valuation of intangible assets.

3. Explain the procedure for amortizing intangible assets.

4. Describe the types of intangible assets.

5. Explain the conceptual issues related to goodwill.

6. Describe the accounting procedures for recording goodwill.

7. Explain the accounting issues related to intangible asset impairments.

8. Identify the conceptual issues related to research and development costs.

9. Describe the accounting for research and development and similar costs.

10. Indicate the presentation of intangible assets and related items.

Learning ObjectivesLearning Objectives

3

Marketing-related

Customer-related

Artistic-related

Contract-related

Technology-related

Goodwill

Intangible Asset Issues

Types of Intangibles

Impairment of Intangibles

Research and Development

Costs

Presentation of Intangibles and Related Items

Characteristics

Valuation

Amortization

Limited-life intangibles

Indefinite-life intangibles other than goodwill

Goodwill

Summary

Identifying R&D

Accounting for R&D

Similar costs

Conceptual questions

Intangible assets

R&D costs

Intangible AssetsIntangible Assets

4

Intangible Asset IssuesIntangible Asset Issues

LO 1 Describe the characteristics of intangible assets.

Characteristics(1) Lack physical existence.

(2) Not financial instruments.

Normally classified as long-term asset.

Common types of intangibles:

Patents

Copyrights

Franchises or licenses

Trademarks or trade names

Goodwill

5


LO 2 Identify the costs to include in the initial valuation of intangible assets.

Purchased Intangibles: Recorded at cost.

Includes all costs necessary to make the intangible asset ready for its intended use.

Typical costs include:

► Purchase price.

► Legal fees.

► Other incidental expenses.

Valuation

6


LO 2 Identify the costs to include in the initial valuation of intangible assets.

Valuation

Internally Created Intangibles:

Generally expensed.

Only capitalize direct costs incurred in developing the intangible, such as legal costs.

7


LO 3 Explain the procedure for amortizing intangible assets.

Amortization of Intangibles

Limited-Life Intangibles:

Amortize by systematic charge to expense over useful life.

Credit asset account or accumulated amortization.

Useful life should reflect the periods over which the asset will contribute to cash flows.

Amortization should be cost less residual value.

8




Indefinite-Life Intangibles:

No foreseeable limit on time the asset is expected to provide cash flows.

No amortization.

Must test indefinite-life intangibles for impairment at least annually.

9



Illustration 12-1Accounting Treatmentfor Intangibles


10

Types of IntangiblesTypes of Intangibles

LO 4 Describe the types of intangible assets.

Six Major Categories:

(1) Marketing-related.

(2) Customer-related.

(3) Artistic-related.

(4) Contract-related.

(5) Technology-related.

(6) Goodwill.

11



Marketing-Related Intangible Assets Examples:

► Trademarks or trade names, newspaper mastheads, Internet domain names, and non-competition agreements.

In the United States trademark or trade name has legal protection for indefinite number of 10 year renewal periods.

Capitalize acquisition costs.

No amortization.

12



Customer-Related Intangible Assets Examples:

► Customer lists, order or production backlogs, and both contractual and non-contractual customer relationships.

Capitalize acquisition costs.

Amortized to expense over useful life.

13



Illustration: Green Market Inc. acquires the customer list of a large newspaper for $6,000,000 on January 1, 2012. Green Market expects to benefit from the information evenly over a three-year period. Record the purchase of the customer list and the amortization of the customer list at the end of each year.

Customer List 6,000,000Jan. 1

Cash 6,000,000

Amortization expense 2,000,000Dec. 31201020112012

Customer list2,000,000

14


Artistic-Related Intangible Assets Examples:

► Plays, literary works, musical works, pictures, photographs, and video and audiovisual material.

Copyright granted for the life of the creator plus 70 years.

Capitalize costs of acquiring and defending.

Amortized to expense over useful life.

Mickey Mickey MouseMouseandand

LO 4

15


LO 4

Examples:

► Franchise and licensing agreements, construction permits, broadcast rights, and service or supply contracts.

Franchise (or license) with a limited life should be amortized to expense over the life of the franchise.

Franchise with an indefinite life should be carried at cost and not amortized.

Contract-Related Intangible Assets

16



Technology-Related Intangible Assets Examples:

► Patented technology and trade secrets granted by the U.S. Patent and Trademark Office.

Patent gives holder exclusive use for a period of 20 years.

Capitalize costs of purchasing a patent.

Expense any R&D costs in developing a patent.

Amortize over legal life or useful life, whichever is shorter.

17



Illustration: Harcott Co. incurs $180,000 in legal costs on January 1, 2012, to successfully defend a patent. The patent’s useful life is 20 years, amortized on a straight-line basis. Harcott records the legal fees and the amortization at the end of 2012 as follows.

Patents 180,000Jan. 1

Cash 180,000

Amortization expense 9,000Dec. 31

Patents9,000

18


LO 5 Explain the conceptual issues related to goodwill.

GoodwillConceptually, represents the future economic benefits arising from the other assets acquired in a business combination that are not individually identified and separately recognized.

Only recorded when an entire business is purchased.

Goodwill is measured as the excess of ...

cost of the purchase overover the FMV of the identifiable net assets purchased.

Internally created goodwill should not be capitalized.

19

Illustration: Multi-Diversified, Inc. decides that it needs a parts division to supplement its existing tractor distributorship. The president of Multi-Diversified is interested in buying Tractorling Company. The illustration presents the statement of financial position of Tractorling Company.

Recording GoodwillRecording Goodwill

LO 6 Describe the accounting procedures for recording goodwill.

Illustration 12-3

20

Illustration: Multi-Diversified investigates Tractorling’s underlying assets to determine their fair values.



Tractorling Company decides to accept Multi-Diversified’s offer of $400,000. What is the value of the goodwill, if any?

Illustration 12-4

21



Illustration 12-5

Illustration: Determination of Goodwill.

22



Property, Plant, and Equipment 205,000

Patents 18,000

Inventories 122,000

Receivables 35,000

Cash 25,000

Goodwill 50,000

Liabilities 55,000

Cash 400,000

Illustration: Multi-Diversified records this transaction as follows.

23

Example: Global Corporation purchased the net assets of Local Company for $300,000 on December 31, 2012. The balance sheet of Local Company just prior to acquisition is:



Assets Cost FMVCash 15,000$ 15,000$ Receivables 10,000 10,000 Inventories 50,000 70,000 Equipment 80,000 130,000

Total 155,000$ 225,000$

Liabilities and EquitiesAccounts payable 25,000$ 25,000$ Common stock 100,000 Retained earnings 30,000

Total 155,000$ 25,000$

FMV of Net Assets = $200,000

24 LO 6 Describe the accounting procedures for recording goodwill.

Book Value = $130,000

Fair Value = $200,000

Purchase Price = $300,000

Revaluation$70,000

Goodwill$100,000


Example: Global Corporation purchased the net assets of Local Company for $300,000 on December 31, 2012. The value assigned to goodwill is determined as follows:

25



Calculation of Goodwill:Cash 15,000$ Receivables 10,000 Inventories 70,000 Equipment 130,000 Accounts payable (25,000)

FMV of identifiable net assets 200,000 Purchase price 300,000

Goodwill 100,000$

Example: Global Corporation purchased the net assets of Local Company for $300,000 on December 31, 2012. The value assigned to goodwill is determined as follows:

26 LO 6 Describe the accounting procedures for recording goodwill.


Journal entry recorded by Global:

Cash 15,000Receivables 10,000Inventory 70,000Equipment 130,000Goodwill 100,000

Accounts payable25,000

Cash300,000

Example: Global Corporation purchased the net assets of Local Company for $300,000 on December 31, 2012. Prepare the journal entry to record the purchase of the net assets of Local.

27

GoodwillGoodwill

Goodwill Write-off

Goodwill considered to have an indefinite life.

Should not be amortized.

Only adjust carrying value when goodwill is impaired.


Bargain Purchase

Purchase price less than the fair value of net assets acquired.

Amount is recorded as a gain by the purchaser.

28

Impairment of Intangible AssetsImpairment of Intangible Assets

Impairment of Limited-Life Intangibles

LO 7 Explain the accounting issues related to intangible-asset impairments.

Same as impairment for long-lived assets.

1. If the sum of the expected future net cash flows is less than the carrying amount of the asset, an impairment has occurred (recoverability test).

2. The impairment loss is the amount by which the carrying amount of the asset exceeds the fair value of the asset (fair value test).

The loss is reported as part of income from continuing operations, “Other expenses and losses” section.

29

Presented below is information related to copyrights owned by Botticelli Company at December 31, 2012.

Cost 8,600,000$ Carrying amount 4,300,000 Expected future net cash flows 4,000,000 Fair value 3,200,000



The copyright has a remaining useful life of 10 years.

(a) Prepare the journal entry (if any) to record the impairment of the asset at December 31, 2012.

(b) Prepare the journal entry to record amortization expense for 2013 related to the copyrights.

30



Recoverability test: If the sum of the expected future net cash flows is less than the carrying amount of the asset, an impairment has occurred.

Expected future cash flow 4,000,000$ Carrying value 4,300,000

(300,000)$

Asset is ImpairedAsset is Impaired

31



(a) Prepare the journal entry (if any) to record the impairment of the asset at December 31, 2012.

Fair value test:Carrying amount 4,300,000$ Fair value 3,200,000 Loss on impairment (1,100,000)$

Loss on impairment 1,100,000

Copyrights 1,100,000

32



(b) Prepare the journal entry to record amortization expense for 2013 related to the copyrights.

Carrying amount 3,200,000$ Useful life 10 yearsAmortization per year 320,000$

÷÷

Amortization expense 320,000

Copyrights 320,000

33


Impairment of Indefinite-Life Intangibles Other than Goodwill


Should be tested for impairment at least annually.

Impairment test is a fair value test.

► If the fair value of asset is less than the carrying amount, an impairment loss is recognized for the difference.

► Recoverability test is not used.

34

Illustration 12-7

Illustration: Arcon Radio purchased a broadcast license for $2,000,000. Arcon Radio has renewed the license with the FCC twice, at a minimal cost. Because it expects cash flows to last indefinitely, Arcon reports the license as an indefinite-life intangible asset. Recently the FCC decided to auction these licenses to the highest bidder instead of renewing them. Arcon Radio expects cash flows for the remaining two years of its existing license. It performs an impairment test and determines that the fair value of the intangible asset is $1,500,000.



35


Impairment of Goodwill


Two Step Process:

Step 1: If fair value is less than the carrying amount of the net assets (including goodwill), then perform a second step to determine possible impairment.

Step 2: Determine the fair value of the goodwill (implied value of goodwill) and compare to carrying amount.

36

Presented below is net asset information related to the Mischa Division of Santana, Inc. as of December 31, 2012 (in millions):



Management estimated its future net cash flows from the division to be $400 million. Management has also received an offer to purchase the division for $335 million. All identifiable assets’ and liabilities’ book and fair value amounts are the same.

37



Instructions

(a) Prepare the journal entry (if any) to record the impairment at December 31, 2012.

(in millions)Fair valueCarrying amount, net of goodwillImplied goodwillCarrying value of goodwillLoss on impairment

Step 1: The fair value of the reporting unit is below its carrying value. Therefore, an impairment has occurred.

Step 2:

Loss on impairment 25,000,000

Goodwill 25,000,000

$ 335160175200

$ (25)

38



Instructions

(b) At December 31, 2011, it is estimated that the division’s fair value increased to $345 million. Prepare the journal entry (if any) to record this increase in fair value.

No entry necessary.

Adjusted carrying amount of the goodwill is its new accounting basis.

Subsequent reversal of recognized impairment losses is not permitted under SFAS No. 142.

39



Summary of Impairment TestsIllustration 12-11

40

Research and Development CostsResearch and Development Costs

LO 8 Identify the conceptual issues related to research and development costs.

Frequently results in something that a company patents or copyrights such as:

new product,

process,

idea,

formula,

composition, or

literary work.

Research and development (R&D) costs are not in themselves intangible assets.

41



Companies spend considerable sums on research and development.

Illustration 12-12

42

Identifying R & D Activities


Research ActivitiesPlanned search or critical investigation aimed at discovery of new knowledge.

ExamplesLaboratory research aimed at discovery of new knowledge; searching for applications of new research findings.

Development ActivitiesTranslation of research findings or other knowledge into a plan or design for a new product or process or for a significant improvement to an existing product or process whether intended for sale or use.

ExamplesConceptual formulation and design of possible product or process alternatives; construction of prototypes andoperation of pilot plants.

Illustration 12-13


43

Accounting for R & D ActivitiesCosts Associated with R&D Activities:

Materials, Equipment, and Facilities.

Personnel.

Purchased Intangibles.

Contract Services.

Indirect Costs.


LO 9 Describe the accounting for research and development and similar costs.

44

Costs Similar to R & D Costs

Start-up costs for a new operation.

Initial operating losses.

Advertising costs.

Computer software costs.



45

Cost of equipment acquired that will have alternative uses in future R&D projects over the next 5 years.

Materials consumed in R&D projects

Consulting fees paid to outsiders for R&D projects

Personnel costs of persons involved in R&D projects

Indirect costs reasonably allocable to R&D projects

Materials purchased for future R&D projects

$330,000

59,000

100,000

128,000

50,000

34,000

$66,000

59,000

100,000

128,000

50,000

0

R&D R&D ExpenseExpense

$403,000

$330,000 / 5 = $66,000


Compute the amount to be reported as research and development expense.


46

Balance Sheet Intangible assets shown as a separate item.

Reporting is similar to the reporting of property, plant, and equipment.

Contra accounts may not be shown for intangibles.

Companies should report as a separate item all intangible assets other than goodwill.

Presentations of Intangibles and Related ItemsPresentations of Intangibles and Related Items

LO 10 Indicate the presentation of intangible assets and related items.

Presentation of Intangible Assets

47

Income Statement Report amortization expense and impairment losses in

continuing operations.

Total R&D costs charged to expense must be disclosed.

Presentations of Intangibles and Related ItemsPresentations of Intangibles and Related Items


Presentation of Intangible Assets

48

Presentations of IntangiblesPresentations of Intangibles


Illustration 12-15

49

Presentations of R&D CostsPresentations of R&D Costs


Illustration 12-16

50 LO 11 Understand the accounting treatment for computer software costs.

Diversity in PracticeCompanies can either

purchase computer software or

create it.

How should companies account for the costs of developing software?

Should they expense such costs immediately, or capitalize and amortize them in the future?

ACCOUNTING FOR COMPUTER SOFTWARE COSTSACCOUNTING FOR COMPUTER SOFTWARE COSTS


The Profession’s PositionFASB ASC 985-20-05 - Major recommendations of this pronouncement are:

1. Until a company has established technological feasibility for a software product, it should charge to R&D expense the costs incurred in creating the product.

2. Technological feasibility is established when the company has completed a detailed program design or a working model.



Accounting for Capitalized Software Costs

If companies are to capitalize software costs, then they must establish a proper amortization pattern.

As a basis for amortization, one of two amounts is used:

1. the ratio of current revenues to current and anticipated revenues (the percent-of-revenue approach), or

2. the straight-line method over the remaining useful life of the

asset (straight-line approach).

Must use whichever of those amounts is greater.



Illustration: AT&T has capitalized software costs of $10 million, and current (first-year) revenues from sales of this product of $4 million. AT&T anticipates earning $16 million in additional future revenues from this product; it estimates that the product has an economic life of four years. Under the two approaches, the calculations are as follows for the first year’s amortization:

Percent-of-revenue approach Straight-line approach



Reporting Software Costs

Companies should report the following information relating to software.

1. Unamortized software costs.

2. The total amount charged to expense and the amounts, if any, written down to net realizable value.


55

RELEVANT FACTS

Like GAAP, under IFRS intangible assets (1) lack physical substance and (2) are not financial instruments. In addition, under IFRS an intangible asset is identifiable. To be identifiable, an intangible asset must either be separable from the company (can be sold or transferred) or it arises from a contractual or legal right from which economic benefits will flow to the company. Fair value is used as the measurement basis for intangible assets under IFRS,

As in GAAP, under IFRS the costs associated with research and development are segregated into the two components.

Costs in the research phase are always expensed under both IFRS and GAAP.

Under IFRS costs in the development phase are capitalized once technological feasibility is achieved.

56

RELEVANT FACTS

IFRS permits revaluation on limited-life intangible assets. Revaluations are not permitted for goodwill and other indefinite-life intangible assets.

IFRS requires an impairment test at each reporting date for long-lived assets and intangibles and records an impairment if the asset’s carrying amount exceeds its recoverable amount. The recoverable amount is the higher of the asset’s fair value less costs to sell and its value-in-use. Value-in-use is the future cash flows to be derived from the particular assets, discounted to present value.

57

End of Lecture 14End of Lecture 14

Issues in Accounting

Documents